2020 (3) TMI 331 - AT - Income Tax

TP Adjustment - ALP of a specified domestic transaction - AO made a reference for determination of the ALP of specified domestic transaction whereas the TPO determined ALP of the international transaction - HELD THAT - The case of the assessee is founded on the premise that the correct value of the SDT to be reported in Column no. 9 of Form No. 3CEB was ₹ 2,60,04,296/-, which was wrongly reported in Column no. 8 and vice versa . We do not understand any raison d etre for the assessee in reporting, at all, the correct value of the transactions of the nature prescribed in section 92BA in the first instance, when it did not cross the threshold of ₹ 5.00 crore, so as to become SDT. The fact that such transactions did not become SDT and required no reporting in Form No. 3CEB coupled with the fact that the assessee still reported it and that too, in a wrong column, gives some strength to the view point canvassed by the ld. DR that the assessee wanted to mislead the Revenue by resorting to the tactic with the ulterior motive. In the ultimate analysis, we hold that no infirmity can be found in the TPO s action in determining the ALP of the international transaction of ₹ 7.07 crore. Treatment of foreign exchange (forex) gain/loss given by the authorities as an item of non-operating nature in the computation of the ALP of the assessee as well as comparables - Notes forming part of the Accounts of the assessee for the year under consideration that one of the transactions involving fluctuation in foreign currency is in the capital field, which is, Purchase of capital goods worth ₹ 13,85,590/-. Forex gain/loss in respect of such a transaction cannot be considered as a part of operating expense/income. The ld. AR candidly admitted that the TPO considered forex gain/loss as non-operating not only for the assessee but also for the comparables. In view of the foregoing discussion, we are of the considered opinion that the amount of foreign exchange gain/loss arising out of revenue transactions is required to be considered as an item of operating revenue/cost, both for the assessee as well as the comparables. Comparability of companies - HELD THAT - Refracting to functions carried out by the assessee as that of providing Software Development and Support services in the areas of embedded multimedia, multimedia applications and communication systems as per the requirements of its AEs companies functionally dissimilar with that of assessee need to be deselected from final list. One needs to examine the comparability position on year to year basis independently. For one year, a company may be comparable and for the next year, it may cease to be so for a variety of reasons. Turnover filter - Upper turnover filter is fixed at ₹ 250 crores and lower turnover filter is fixed at ₹ 2.50 crore - Companies which do not pass turnover filter approved by the DRP need to be excluded. Computation of OP/OC of comparable company - treatment given by the authorities below to the Provision for bad and doubtful debts as non-operating - The provision for doubtful debts has a direct relation with the sales made by a company. In the same way in which the amount of sales is an item of operating revenue, the amount of provision for doubtful debts, having direct link with the sales, is also an item of operating expense. In our considered opinion, Provision for doubtful debts cannot be treated as a non-operating expense. We, therefore, direct to include the amount of Provision for doubtful debts in the expense side of this company for calculating the profit margin. Direct to include Reserve for doubtful debts as an item of operating expenses in calculating the operating profit margin of the company. Operating expenses exclusion for calculating the profit margin in the process of determination of the ALP - Once a particular expenditure itself is disallowed, there can be no question of including it in the Operating expenses for calculating the profit margin in the process of determination of the ALP.While upholding the disallowance, we direct to exclude ₹ 5.00 lakh from the Operating expenses of the assessee for the purpose of calculation of its ALP.

Summary

Issues Involved:
1. Validity of the reference made by the AO to the TPO for determining the ALP of specified domestic transactions and international transactions.
2. Treatment of foreign exchange gain/loss in the computation of ALP.
3. Comparability of certain companies included/excluded by the TPO.
4. Treatment of provision for bad and doubtful debts in the computation of ALP.
5. Disallowance of ?5.00 lakh from office expenses.

Detailed Analysis:

1. Validity of the Reference to TPO:
The first issue raised concerns the validity of the reference made by the AO to the TPO for determining the ALP of specified domestic transactions (SDT) and international transactions. The AO made a reference to the TPO for determining the ALP of SDT amounting to ?7.07 crore and the international transaction of ?Nil. The TPO determined the ALP of the international transaction with a book value of ?7.07 crore, proposing a transfer pricing adjustment of ?1.11 crore. The assessee contended that the TPO was incompetent to determine the ALP of the international transaction when the reference was only for the SDT. The Tribunal found no substance in the assessee's contention, noting that the AO was bound to make a reference to the TPO based on the reported value in Form No. 3CEB. The Tribunal held that the TPO correctly determined the ALP of the reported transaction of ?7.07 crore, albeit with the nomenclature of SDT instead of an international transaction.

2. Treatment of Foreign Exchange Gain/Loss:
The second issue pertains to the treatment of foreign exchange gain/loss in the computation of ALP. The authorities treated forex gain/loss as non-operating in nature. The Tribunal found merit in the contention that forex gain/loss should be considered as operating revenue/cost, but only in respect of transactions in the revenue field and not the capital field. The Tribunal directed that the amount of forex gain/loss arising out of revenue transactions should be considered as an item of operating revenue/cost for both the assessee and the comparables.

3. Comparability of Certain Companies:
The third issue involves the comparability of certain companies included/excluded by the TPO. The Tribunal examined the functional profile of the assessee and the companies in question:

- Thirdware Solutions: The Tribunal found that this company was not exclusively engaged in rendering software services and ordered its exclusion from the list of comparables.
- Infobeans System India Ltd.: The Tribunal upheld the inclusion of this company, noting that it was primarily engaged in software development services.
- R.S. Software (India) Ltd.: The Tribunal ordered the exclusion of this company as its turnover exceeded the upper turnover filter approved by the DRP.

4. Treatment of Provision for Bad and Doubtful Debts:
The fourth issue concerns the treatment of the provision for bad and doubtful debts in the computation of ALP. The Tribunal held that the provision for doubtful debts, having a direct link with sales, should be considered as an item of operating expense. The Tribunal directed the inclusion of the provision for doubtful debts in the expense side for calculating the profit margin of the comparables.

5. Disallowance of ?5.00 Lakh from Office Expenses:
The fifth issue involves the disallowance of ?5.00 lakh made by the AO from office expenses. The AO observed that the details of expenses claimed under the head "Office expenses" were not fully verifiable. The assessee did not challenge this disallowance before the DRP, implying acceptance. The Tribunal upheld the disallowance but directed the exclusion of ?5.00 lakh from the operating expenses for calculating the profit margin in the process of determination of the ALP.

Conclusion:
The Tribunal set aside the impugned order and remitted the matter to the AO/TPO for fresh determination of the ALP in terms of the discussion made. The appeal was partly allowed for statistical purposes.